Let’s say you have $100,000 to invest today. Given the scary stuff that’s been going on in the market it is tempting to do something really safe, like buying government bonds. So let’s say you buy $100,000 worth of Government of Canada bonds, maturing five years from now. You will get interest of 1.16% before tax, or .6% after tax. Five years from now you will have $103,000.
But what if you do something else by, for example, buying shares of Bell Canada? At today’s price you could buy 2,623 shares. Bell pays a dividend of $2.07 per year, equal to 5.42%. What happens over five years? Due to the dividend tax credit you get to keep 77% of your dividends, so you net $4,181 per year or $20,903. It looks like a no-brainer – that’s almost seven times better than the yield on the bonds.
Of course the bonds can’t go down in value, if held to maturity, but Bell stock could. However, if Bell stock lost $6.85 per share, or 18% of its value, you would still break even. That’s assuming that Bell does not increase its dividend over the five year period. In fact, Bell has increased its dividend seven times in the past five years, by a total of 57%. If it does the same over the next five years, the dividend would end up at $3.25 per share. That’s a yield of 8.5% on the current price, and experience suggests that the shares will be worth more then, than they are now.
This calculation is not unique to Bell of course. It is just as true for many telecom, pipeline, utility and financial stocks. Buying a bundle of such stocks is not a guarantee that you won’t lose money over a five year time period, but it is a very good bet indeed. This is why we have so many stable, high dividend payers in our list of top portfolio holdings.
This arithmetic is not a secret and it does not require much time or energy to figure this out. So why are investors fleeing quality stocks such as Bell, and buying Government bonds at ridiculously low interest rates? The only answer can be fear. Fear of what might happen in Europe, fear of a recession in North America, fear of the future. When it comes to investing, emotion is the enemy of reason, and it is a very powerful enemy indeed.
If there is one important lesson that emerged from the market crash of 2008, it is that only those who sold realized real losses. The market returned to its mid 2008 levels in around two years. Of our key holdings during those years only one cut its dividend, compared to over a dozen that increased them. We see no reason to think that the current market correction is any different, and it is our intention to act accordingly.
Disclosure: The author and clients of Baskin Financial own share in BCE